Reading: Towards an Optimal Capital Structure

So far, we have talked extensively about one major benefit of debt financing, tax savings, as well as a set of disadvantages of debt financing, namely the various incentive problems that (too much) debt can bring about (asset substitution problem, underinvestment problem, etc.).

In this section, we want to complete the discussion of the most important advantages and disadvantages of debt financing. Then we want to discuss how firms can attempt to solve the resulting trade-offs and find an "optimal" capital structure.